Got up this morning to see that Morgan Kelly has another chilling article in The Irish Times. It is required reading. Prof. Kelly is willing to say things that other people are not. On the whole issue of public debt sustainability, which we looked at recently, he is pretty clear.
Irish insolvency is now less a matter of economics than of arithmetic. If everything goes according to plan, as it always does, Ireland’s government debt will top €190 billion by 2014, with another €45 billion in Nama and €35 billion in bank recapitalisation, for a total of €270 billion, plus whatever losses the Irish Central Bank has made on its emergency lending. Subtracting off the likely value of the banks and Nama assets, Namawinelake (by far the best source on the Irish economy) reckons our final debt will be about €220 billion, and I think it will be closer to €250 billion, but these differences are immaterial: either way we are talking of a Government debt that is more than €120,000 per worker, or 60 per cent larger than GNP.
I tend to be with Namawinelake on this one. I’d like to know how the €250 billion of debt is expected to materialise. If this comes to pass (and Prof. Kelly has some previous on this) then the country will be insolvent. There is no doubt about that. However, in my view the total debt by 2014 will be closer to €200 billion. This figure puts us on the border of insolvency but it is not one that makes default “inevitable”.
The €220 billion estimate from Namawinelake is from this comment in February and is reproduced here. At least this provides some details to work from.
As regards government debt in 2014, for the time being I will go with the government’s own deficit projections (€43bn 2011-2014) though the balance of opinion seems to be that GDP growth will be less than official projections. I believe the Promissory notes will need be drawn down sooner rather than later and not in an even 10-years but frankly this is all tinkering around the edges. The real question is what will happen with ECB operations that see €100bn in our banks at present, how long can this emergency funding continue (it started in Sept 2008 in earnest) and will part of that end up on the national debt?
So general govt debt of €148bn in 2010 + €43bn deficit 2011-2014 + additional capital for banks (€35bn earmarked of which €25bn is described as a contingency) + debt redemption nil (rollover) + NAMA €45bn (€40bn bonds including pyt for sub-€20m exposures and €5bn development debt) + swapping of ECB/CBI ELA for national debt x,
So €271bn + x for ECB/CBI ELA swap for general government debt.
Obviously NAMA will have some value as will ELA and we start off with some funds in the NTMA/NPRF so the net will be less than that , but I would have said €220bn as a rough ballpark.
There is not a lot wrong with this analysis. Since February we have learned that developer loans of less than €20 million will not be transferred to NAMA. Of course, this doesn’t eliminate the losses it just makes the potential NAMA losses a little smaller. It makes the potential bank losses bigger by the same amount, but we now know that the banks will require €24 billion to cover these losses and become “over-capitalised” rather than the full €35 billion of the contingency fund that was used in the debt estimate above.
This will bring the €220 billion debt estimate for 2014 down to below €210 billion and not too far from what we have forecast. Of course, even that estimate is plagued with uncertainty as we have recently noted.
There are other issues related to the banking collapse that are not included. These are the final outcome of the NAMA process, whether the shutdown of Anglo and INBS will require further injections of capital, and how to unwind the €140 billion of liquidity the banks have taken from the European and Irish Central Banks. There is also the long-term hope that we will be able to sell off our stakes in the two ‘pillar’ banks to recoup some of the money swallowed by the bailout. There is a great deal of uncertainty about all of these.
An extreme negative outcome an any of these could bring the debt level close to Prof. Kelly’s prediction of €250 billion. It would be nice if he had told us which of these he expects to go south. There are four items listed above and it might be easier to bet on one unspecified loser than try to find four winners but I’m willing with the following:
- Namawinelake’s estimate that NAMA is currently nursing losses of around 11% on the loans it has obtained based on the site’s NWL Index. The index “is about NAMA breaking even” and I’m not exactly sure how to translate this into a monetary loss, but NAMA has paid €30.5 billion for the loans it acquired. This would indicate a loss of around €3.5 billion.
- The Central Bank’s belief that Anglo and INBS will not require any additional capital from the State. If they do there are some senior bondholders left that have to be first in the burden-sharing line.
- That the central bank liquidity can we wound down over time. Should we be looking to end a situation that has our banks getting €80 billion from the ECB at the extraordinary low rate of 1.25% and a further €65 billion from the Central Bank of Ireland at around 3.00%, which itself is also from the ECB? This is a huge implicit subsidy for the banks and, by association, us.
- We can forget about selling the so-called “pillar” banks in the timeframe considered. We may be able to do so at some stage in the future but this does not enter into the medium-term sustainability analysis.
If all of these come to pass we can expect the 2014 debt level to be in the region around €205 billion. If nominal GDP by 2014 got to €170 billion then the debt/GDP ratio would be around 120%. The design of the Promissory Notes means that the amount of cash we will have had to borrow will be around €18 billion less, bringing the debt that we will actually have to pay interest on to around 108% of GDP and we would have to commit around 5% of GDP per annum to interest costs. As I said here.
There remain some significant uncertainties that may force a restructuring regardless, but based on what we now know I think we can survive without a default/restructure. The decision may be made to take this option anyway and if the benefits of doing so exceed the costs then the view that the debt is “sustainable” is moot.